Though its progress was restrained by the same liquidity drain that reined in risk trends, the dollar managed a broad recovery this past week. Yet, the conviction behind this move comes with a heavy dose of doubt. Like the questionable rebound for the S&P 500, the currency’s performance may have been more a reversal of the previous period’s momentum rather than a committed change in trend. With the market still working out its convictions for general risk trends and where the Fed stands in the slow shift to a global monetary policy tightening cycle, the return of liquidity will immediately engage the dollar.

Looking ahead to the new week of trading, the first thing to appreciate is the impact that the holiday trading conditions have imposed on the capital markets and the dollar. The Easter holiday took the US, European and Australian amongst other regions offline Friday; and some of those same regions will be off Monday as well. When a significant portion of the global financial system is absent – as it is now – it is exceptionally difficult to generate a market-wide trend. The gaps in the transmission of gluttonous yield chase or panicked selling quickly temper momentum. Expectations of that listlessness can also lead markets to adjust before it hits. That is likely what led equities to recovery the ground lost through the previous weeks and the dollar to do the same.

If there is a low probability of significant trend development – particularly counter-trend – traders see ideal conditions to exploit the same trading approach they have used over the past 16 months: buy short-term dips and sell jumps in volatility. However, this trading approach and the liquidity lull end quickly. That means that when markets are back up to full power, we revert back to earnest trend development. If risk measures start to slip Tuesday and further into the week, it would be a strong indication that a systemic turn is underway. For the sentiment theme to once again guide the dollar, we would need to see a serious engagement and trend.

Outside of the unrealized potential for risk-on-risk-off, dollar traders have a more effective rudder in interest rate expectations. The rebound in Treasury yields (2, 5, 10-year) may have rebound under the same liquidity pretenses as equities this past week, but the buoyancy is more likely to stick. The recent tumble in yields was suspect and likely a short-lived speculative run considering data and Fed commentary we’ve as of late firmly supports the steady Taper of QE and the forecast for a mid-2015 first hike. In fact, a strong TIPS (inflation-protected Treasury) auction this past week and rise in two-year breakeven rates (used to gauge inflation expectations) suggest those expectations are being reinforced.

For tangible catalysts to build – or undermine – US rate forecasts, the docket is pretty light. The Chicago Fed’s national activity index and Markit’s Composite PMI figure are broad measures for economic health. Housing data and durable goods will be viewed as more distant monetary policy fodder. However, this being a relative valuation scheme, we should also keep in mind the general bearing of the dollar’s market counterparts. The ECB has threatened easing to curb EURUSD’s appreciation, BoE expectations are extended, and both China and Japan may be forced to adopt new stimulus if their economic conditions worsen. So, while the Fed’s ‘mid-2015’ time frame may not change; pushing out the tightening schedule for its international peers would make it look significantly more bullish. – JK

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